July 23 (Bloomberg) -- With Digital Generation Inc.’s stock
languishing below the value of deals its executives completed in
the past year, shareholders would double their money if the
television and online advertising businesses were split.

A 71 percent drop since last year’s peak has left Digital
Generation trading at a 44 percent discount to the value of its
net assets, the cheapest multiple among U.S. ad companies larger
than $250 million, according to data compiled by Bloomberg. At
$295 million, its market value trails the $560 million Digital
Generation spent creating its online unit through the 2011
purchases of MediaMind Technologies Inc. and EyeWonder LLC.

Digital Generation disclosed last week that it hired
Goldman Sachs Group Inc. to explore options including a sale,
less than two months after a person familiar with the matter
said the company rejected an offer from Extreme Reach Inc.
exceeding $20 a share. Divorcing the television and online
advertising units could push the value of the company’s assets
to $25 a share, according to Janney Montgomery Scott LLC, 133
percent higher than last week’s closing price.

“I do worry that this Internet segment is being stifled a
bit by forced integration” with the TV business, Richard
Fetyko, a New York-based analyst with Janney Montgomery, said in
a phone interview. “It may be a difficult one from an ego
standpoint because they just acquired some of these assets a
year ago, but I think that they are trying to fit a square peg
into a round hole.”

Two Businesses

JoAnn Horne, an outside spokeswoman for Irving, Texas-based
Digital Generation, said the company had no comment beyond last
week’s statement about the hiring of Goldman Sachs to explore
alternatives.

Digital Generation is organized into two divisions. One
unit distributes advertisements to television and radio
stations, while the other helps customers manage online
marketing campaigns. The company built the Internet business
with the 2011 acquisitions of MediaMind for $499 million and
EyeWonder for $61 million. To fund the deals, the company
increased long-term borrowing to $435 million as of March from
zero in June 2011.

The company as currently structured trades for about five
times this year’s estimated earnings before interest, taxes,
depreciation and amortization, Christopher Ferris, an analyst
with Noble Financial Group Inc., wrote in a report on July 17,
when the shares closed at $11.80. The stock lost 0.3 percent to
$10.68 today, posting a smaller slump than the 0.9 percent
decline in the Standard & Poor’s 500 Index.

‘Worth More’

Digital Generation’s online division should be valued at 20
times forecast 2012 Ebitda of $19 million, giving it a valuation
of about $370 million, he said. The TV division’s projected
value is five times estimated profit of $110 million, Ferris
wrote. Given that, and after subtracting estimated year-end net
debt of $376 million, the company should be valued at $19 a
share, he said in the report.

“Clearly, it’s worth more than where the stock’s trading
right now,” he said in a phone interview last week.

The shares, which closed last week at $10.71, trade for
0.56 times book value, or assets minus liabilities, which is
less than all similarly sized peers, data compiled by Bloomberg
show. The ratio dropped to a 10-year low of 0.41 on May 11.

Extreme Reach recently made an offer of more than $20 a
share for rival Digital Generation that was rejected by the
advertising-management company, a person with direct knowledge
of the situation said at the beginning of June. Also last month,
RDG Capital LLC’s Russell Glass said he was weighing an offer
for the company, which has fallen from last year’s peak of
$37.01 in May. RDG accumulated a 4.9 percent stake, Glass said
June 7.

Prior Attempt

Digital Generation also tried to sell itself a year ago,
when its name was DG FastChannel, three people with knowledge of
the situation said at the time. That process stalled after its
acquisition of MediaMind, a person with direct knowledge of the
situation said last month.

Companies from Yahoo! Inc. to Adobe Systems Inc. and Dentsu
Inc. might be interested in Digital Generation’s Internet
business, said Janney Montgomery’s Fetyko, who said Digital
Generation’s value would range between $18 and $25 a share in a
breakup.

“The easiest, most straightforward way of increasing the
value” of the company is jettisoning the Internet business,
Fetyko said in a phone interview. That segment “consists of the
acquisition of MediaMind, which is a really established, really
well-recognized online ad delivery, campaign management and ad
delivery service.”

Robert Coolbrith, an analyst for ThinkEquity LLC in San
Francisco, said Yahoo may be interested in the “long-term
strategic value” that the online ad management business segment
could bring as it competes with Google Inc., which bought
advertising company DoubleClick Inc. in 2008.

Cash Generation

Dana Lengkeek, a spokeswoman for Yahoo, said the company
doesn’t comment on rumors and speculation. Yahoo’s new chief
executive officer, former Google official Marissa Mayer, started
her job last week. Colleen Rodriguez, a spokeswoman for Adobe,
didn’t respond to phone calls and e-mails seeking comment. James
Miller, a representative for Dentsu, didn’t respond to an e-mail
requesting comment.

Private-equity firms might be drawn to the TV business
given its cash generation, Coolbrith said.

“The traditional TV ad delivery business is very
profitable,” he said. “Investors may have questioned the
rationale behind the foray into the online business.” The
challenge, though, is that “it is increasingly clear that there
are limited opportunities for reinvestment of cash flow within
the TV business itself.”

Deterring Buyers

The company borrowed to fund last year’s acquisitions,
driving debt above the stock’s market value. That may deter
private-equity buyers interested in the entire company or
breaking it up, Noble’s Ferris said.

“It makes sense for a private-equity-type player, but
private equity doesn’t particularly like a company that is
levered up,” he said in a phone interview.

Digital Generation has accumulated debt amounting to 4
times Ebitda, compared with the average of 2.5 times among U.S.
advertising firms valued at $250 million or more, according to
data compiled by Bloomberg. Still, Digital Generation will
produce about $70 million to $100 million in free cash flow
annually, meaning it can pay off its net debt in three to four
years, Ferris said.

Short sellers are boosting bets that the shares, already
trading at a discount to net assets, will keep falling. The
percentage of stock borrowed and then sold was 10.3 percent as
of July 18 and climbed to a 21-month high of 12.8 percent on
June 13, according to data compiled by Markit.

Biggest Shareholders

Two of the company’s biggest shareholders endorse Digital
Generation’s evaluation of deals and other options.

“We are supportive of the board’s decision to formally
explore strategic alternatives,” RDG Capital’s Glass said last
week. “We and other significant shareholders have communicated
this view to management and appreciate their responsiveness to
shareholders’ input.”

Jim Roumell, the founder of Roumell Asset Management LLC,
said in a phone interview from Chevy Chase, Maryland, that the
company’s debt level isn’t enough to deter a potential buyer
because the business generates so much cash.

While Roumell, whose fund holds about 5 percent of Digital
Generation’s shares, said he sees the value of the two segments
of the company being kept together, the company should explore
any option that would boost returns for stockholders.

“If someone shows up with a fair price, I’m not wed to the
company being kept together,” he said. “I’m wed to maximizing
shareholder value.”